Keep the Faith

Jonathan Clements

FOREIGN STOCKS have become the investment that folks love to hate—and it’s easy to understand why. In the current decade’s first six full calendar years, foreign shares trailed the S&P 500 by almost nine percentage points a year—and they’re on track to lag behind the U.S. again in 2016.

But is this recent performance a good guide to the future? Almost certainly not. Foreign stocks are far less expensive than U.S. shares. On top of that, history tells us that there are plenty of decades when foreign stocks outpaced U.S. shares. I’ve been perusing the “big picture” chart from Investments Illustrated that shows the performance of different asset classes since year-end 1925.

At first blush, foreign stocks look like a dubious choice, returning 7.9% a year over the past nine decades, versus 9.8% for the S&P 500. But that huge performance gap was driven in large part by the 1940s, when some foreign markets were devastated by the Second World War, and by the 1990s, when the U.S. market was driven to giddy heights by the technology boom. Foreign stocks lagged behind the U.S. market by 13.9 percentage points a year in the 1940s and by 11.1 points in the 1990s.

What if you look at the other six full decades depicted in the chart? There was only one decade—the 1960s—when U.S. stocks outpaced foreign shares. Indeed, foreign shares occasionally proved to be a great diversifier for U.S. stocks, notably in the wretched 1970s, when foreign markets scored 10.1% a year, while U.S. stocks eked out an inflation-lagging 5.8%.

Moreover, if you look at the past 50 years, you find U.S. stocks clocked 9.8% a year, barely ahead of the 9.4% notched by foreign markets. My advice: Keep the faith—and keep those foreign stocks in your portfolio.

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